CORE Metadata, citation and similar papers at core.ac.uk Provided by University of Debrecen Electronic Archive Introduction to Project Finance for Engineers The course material/work/publication is supported by the EFOP-3.4.3-16-2016-00021 "Development of the University of Debrecen for the Simultaneous Improvement of Higher Education and its Accessibility" project. The project is supported by the European Union and co-financed by the European Social Fund. 1 Author: Tünde Jenei Proofreading: Prof. Dr. Edit Szűcs Manuscript closed: 30/April/2018 ISBN 978 - 963 – 490 – 006 - 1 Published by: University of Debrecen Faculty of Engineering 2 Table of Contents 1. DEFINITION OF PROJECT FINANCE ............................................................................... 5 1.1 How can a project financing be identified? ............................................................ 6 1.2 Project finance: when and why? ............................................................................ 8 1.2.1 Advantages ...................................................................................................... 9 1.2.2 Disadvantages.................................................................................................. 9 2. PARTICIPANTS OF PROJECT FINANCING ..................................................................... 11 3. FINANCING SOURCES USED IN PROJECT FINANCING ................................................. 14 4. RISKS AND RISK MITIGATIONS INVOLVED IN PROJECT FINANCING ........................... 18 5. CONTRACTS OF PROJECT FINANCE ............................................................................. 22 5.1. Pre-development agreements ............................................................................ 22 5.2. Construction agreements .................................................................................... 23 5.3. Contractors bonds ............................................................................................... 24 5.4. Operating and maintenance agreements ........................................................... 24 5.5. Sponsor support agreements .............................................................................. 25 5.6. Management agreements ................................................................................... 25 5.7. Representations and warranties ......................................................................... 26 5.8. Project loan/credit agreements .......................................................................... 26 5.8.1 Credit agreements – basic terms ................................................................... 27 5.8.2 Significant provisions of the project finance credit agreement .................... 28 5.9. Covenants ............................................................................................................ 29 5.9.1. Types of covenants ....................................................................................... 30 5.9.2. Project financing covenants ......................................................................... 31 6. FINANCIAL MODELLING AND EVALUATION ............................................................... 34 6.1 model inputs ......................................................................................................... 35 6.2 Model outputs ...................................................................................................... 36 6.3 Macroeconomic assumptions .............................................................................. 36 6.4 Project costs and funding ..................................................................................... 38 3 6.4.1. Project costs ................................................................................................. 38 6.4.2. Project financing ........................................................................................... 41 6.5 Operating revenues and costs .............................................................................. 42 6.6 Loan drawings and debt service ........................................................................... 43 6.7 Accounting and taxation issues ............................................................................ 43 7. EQUITY RETURNS ........................................................................................................ 44 8. DEBT COVER RATIOS ................................................................................................... 44 9. THE BASE CASE AND CHANGES IN ASSUMPTIONS ..................................................... 45 10. SENSITIVITY ANALYSIS .............................................................................................. 45 11. FINANCIAL STRUCTURING AND DOCUMENTATION ................................................. 46 11.1 Debt: equity ratio ............................................................................................... 47 11.2 Debt service ........................................................................................................ 47 11.3 Drawdown of debt and equity ........................................................................... 47 11.4 Interest rates and fees ....................................................................................... 48 11.5 Control of cash flow ........................................................................................... 50 11.6 Debt prepayments and refinancing .................................................................... 50 11.7 Security ............................................................................................................... 51 11.8 Financial close- conditions precedent ................................................................ 52 11.9 Representations and warranties ........................................................................ 54 11.10 Covenants ......................................................................................................... 56 11.11 Events of default .............................................................................................. 56 11.12 Waivers, amendments, and enforcement on default ...................................... 58 4 1. DEFINITION OF PROJECT FINANCE The term “project finance” is used loosely by academics, bankers and journalists to describe a range of financing arrangements. Often bandied about in trade journals and industry conferences as a new financing technique, project finance is actually a centuries-old financing method that predates corporate finance. However with the explosive growth in privately financed infrastructure projects in the developing world, the technique is enjoying renewed attention. The purposes of this chapter are to contrast project finance with traditional corporate financing techniques; to highlight the advantages and disadvantages of project finance and to propose that a single structure underlies every project finance transaction; to explain the myriad of risks involved in these transactions. Project financing techniques date back to at least 1299 A.D. when the English Crown financed the exploration and the development of the Devon silver mines by repaying the Florentine merchant bank, Frescobaldi, with output from the mines. The Italian bankers held a one-year lease and mining concession, i.e., they were entitled to as much silver as they could mine during the year. In this example, the chief characteristic of the project financing is the use of the project’s output or assets to secure financing. Another form of project finance was used to fund sailing ship voyages until the 17th century. Investors would provide financing for trading expeditions on a voyage-by voyage basis. Upon return, the cargo and ships would be liquidated and the proceeds of the voyage split amongst investors. An individual investor then could decide whether or not to invest in the sailing ship’s next voyage, or to put the capital to other uses. In this early example the essential aspect of project financing is the finite life of the enterprise. In corporate finance terms, we can also think of this mandatory liquidation as a fixed dividend policy. The idea of project finance predated the idea of permanent capital entrusted to a group of professional managers who would decide rather autonomously between paying dividends and reinvestment. Project financing has evolved through the centuries into primarily a vehicle for assembling a consortium of investors, lenders and other participants to undertake infrastructure projects that would be too large for individual investors to underwrite. The more recent prominent examples of project finance structures facilitating projects are the construction of the Trans-Alaskan pipeline and exploration and exploitation of the North Sea oil fields. In the late 1990s, the technique has become rather prevalent and is frequently used to finance independent power plants and other infrastructure projects around the world as governments face budgetary constraints. There is no singular definition of project finance. In an article in the Harvard Business Review, Wynant defined project finance as “a financing of a major independent capital investment that the sponsoring company has segregated from its assets and general purpose obligations.” A major player in sponsoring infrastructure projects and providing financing in developing countries, the World Bank defines project finance as the “use of nonrecourse or limited-recourse financing.” Further defining